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CONSTRUCTION PROJECT FINANCING MANAGEMENT
Conference Paper · June 2022
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XII International Symposium Engineering Management and Competitiveness 2022 (EMC 2022)
17-18th June, Zrenjanin, Serbia
CONSTRUCTION PROJECT FINANCING MANAGEMENT
Ali Reza Afshari
Department of Project Management and Construction, Mashhad Branch, Islamic Azad University, Mashhad, Iran
E-mail: afshari@[Link]
Behsa Saeedi
Department of Project Management and Construction, Mashhad Branch, Islamic Azad University, Mashhad, Iran
ABSTRACT
Project financing continues to enjoy strong growth. Many countries have sought a greater role for the private
sector, seeking to balance budgetary constraints against a desire to develop infrastructure, including investment
in areas traditionally seen as the domain of the public sector. Project finance is the long-term financing of
construction projects based upon the projected cash flows of the project rather than the balance sheets of its
sponsors. Project finance is the process of financing a specific economic unit that the sponsors create, in which
creditors share much of the venture’s business risk and funding is obtained strictly for the project itself. Project
finance creates value by reducing the costs of funding, maintaining the sponsors financial flexibility, increasing
the leverage ratios, avoiding contamination risk, reducing corporate taxes, improving risk management, and
reducing the costs associated with market imperfections. This paper provides details on project finance
characteristics and players.
Key words: Construction Project Management, Project Finance, Project Financing Documentation, Project
Financial Management.
INTRODUCTION
Before examining how projects are structured and financed, it is worth asking why sponsors choose
project finance to fund their projects. Project finance is invariably more expensive than raising
corporate funding (Finnerty, 2007). Also, and importantly, it takes considerably more time to organise
and involves a considerable dedication of management time and expertise in implementing,
monitoring and administering the loan during the life of the project. There must, therefore, be
compelling reasons for sponsors to choose this route for financing a particular project. The following
are some of the more obvious reasons why project finance might be chosen: The sponsors may want to
insulate themselves from both the project debt and the risk of any failure of the project, A desire on the
part of sponsors not to have to consolidate the project’s debt on to their own balance sheets. This will,
of course, depend on the particular accounting or legal requirements applicable to each sponsor.
However, with the trend these days in many countries for a company’s balance sheet to reflect
substance over form, this is likely to become less of a reason for sponsors to select project finance,
There may be a genuine desire on the part of the sponsors to share some of the risk in a large project
with others. It may be that in the case of some smaller companies their balance sheets are simply not
strong enough to raise the necessary finance to invest in a project on their own and the only way in
which they can raise the necessary finance is on a project financing basis, A sponsor may be
constrained in its ability to borrow the necessary funds for the project, either through financial
covenants in its corporate loan documentation or borrowing restrictions in its statutes. The purpose of
this article is to address aspects of financing construction projects (Bueno, 2010). More attention is
also paid to project financing documents. This paper contributes to the body of knowledge by
reviewing existing policies, practices, and research efforts in the area of construction project financing.
Meanwhile, the findings from this paper benefit the industry as well, because they are able to provide
the practitioners with a holistic view of construction project financing, thereby enhancing their
knowledge and skills in this regard.
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PROJECT FINANCING IMPLEMENTATION AND MANAGEMENT
The implementation of a project financing is a complicated, time-consuming and difficult operation.
For most projects it is a case of years rather than months from inception of the project to reach
financial close. It is not unheard of for some complex and, perhaps, politically sensitive, projects to
have a gestation period in excess of five years. However, each project will have a unique timetable,
driven largely by the particular dynamics and circumstances of the project. With so many parties
involved having conflicting interests, the issue of effective project management assumes great
significance in most project financings. It does not matter whether the overall responsibility is
assumed by the sponsors and their advisers, or by the lenders and their advisers. What is crucial,
however, is that one of the influential parties assumes overall control for managing the project from its
inception to financial close. Without effective project management, a project can very easily go off the
rails, with each of the parties singularly concentrating on issues and documents that are relevant to it.
Because of the need to understand all aspects of the project with a view to assessing the overall risk
profile, it is often the lenders and their advisers, who are in the best position to manage effectively and
steer a project to financial close (Delmon, 2017).
PROJECT FINANCING PARTIES
One of the complicating and interesting, features of most projects is the considerable number of parties
with differing interests that are brought together with the common aim of being involved to a greater
or lesser extent with a successful project. It is one of the challenges of those involved with a project to
ensure that all of these parties can work together efficiently and successfully and cooperate in
achieving the project’s overall targets. It is inevitably the case that, although all of the parties will
share the same overall aim in ensuring that the project is successful, their individual interests will vary
considerably and, in many cases, will conflict. With many projects, there will be an international
aspect which will involve different project parties located in different jurisdictions and there will often
be tensions between laws and practices differing from one country to another. A common feature in
many project structures is that different parties will have particular roles to play. This is especially so
with many multi-sponsor projects where, for example, one sponsor may also be the turnkey contractor,
whereas another sponsor may be the operator and yet another sponsor may be a supplier of key raw
materials to the project or an offtake of product from the project. Frequently it is the case and
sometimes a requirement of local laws, that one of the sponsors is a local company. Even in those
countries where the involvement of a local company is not a requirement, this can have many
advantages particularly where the foreign sponsors have limited experience of business practices or
laws in the host country. Further, the involvement of a local company offers a degree of comfort, for
the foreign sponsors and lenders alike, that the project as a whole will not be unfairly treated or
discriminated against. No two projects will have the same cast of “players” but the following is a
reasonably comprehensive list of the different parties likely to be involved in a project finance
transaction (Steffen, 2018).
PROJECT FINANCING INVESTORS
These are investors in a project who invest alongside the sponsors. Unlike the sponsors, however,
these investors are looking at the project purely in terms of a return on their investments for the benefit
of their own shareholders. Apart from providing their equity, the investors generally will not
participate in the project in the sense of providing services to the project or being involved in the
construction or operating activities. Third-party investors typically will be looking to invest in a
project on a much longer time frame than, say, a typical contractor sponsor, who will in most cases
want to sell out once the construction has been completed. Many third-party investors are development
or equity funds set up for the purposes of investing in a wide range of projects and they are starting to
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become a valuable source of capital for projects. Typically, they will require some involvement at
board level to monitor their investment (Danielis & Rotaris, 2021).
Banks: The sheer scale of many projects dictates that they cannot be financed by a single lender and,
therefore, syndicates of lenders are formed in a great many of the cases for the purpose of financing
projects. In a project with an international dimension, the group of lenders may come from a wide
variety of countries, perhaps following their customers who are involved in some way in the project. It
will almost certainly be the case that there will be banks from the host country participating in the
financing. This is as much for the benefit of the foreign lenders as from a desire to be involved on the
part of the local lenders. As with the involvement of local sponsors, the foreign lenders will usually
take some comfort from the involvement of local lenders. As is usually the case in large syndicated
loans, the project loan will be arranged by a smaller group of arranging banks. Often the arranging
banks are the original signatories to the loan agreement with the syndication of the loan taking place at
a later date. In such cases the arranging banks implicitly take the risk that they will be able to sell
down the loan at a later stage. However, participating in project financings is a very specialized area of
international finance and the actual participants tend to be restricted to those banks that have the
capability of assessing and measuring project risks. This is not to say that banks not having these skills
do not participate in project financings, but for these banks the risks are greater as they must also rely
on the judgement of the more experienced banks. The complexity of most project financings
necessitates that the arrangers are large banks with experience in this market, often having dedicated
departments of specialists. For the smaller banks with an appetite for this kind of lending, however,
there is usually no shortage of opportunities to participate in loans arranged by the larger banks.
Construction Company: In a construction project the contractor will, during the construction period
at least, be one of the key project parties. Commonly, it will be employed directly by the project
company to design, procure, construct and commission the project facility assuming full responsibility
for the on-time completion of the project facilities usually referred to as the “turnkey” model. The
contractor will usually be a company well known in its field and with a track record for constructing
similar facilities, ideally in the same part of the world. In some large Construction projects, a
consortium of contractors is used. In other cases, an international contractor will join forces with a
local contractor. In each of these cases one of the issues that will be of concern to both the project
company and the lenders is whether the contractors in the joint venture will assume joint and several
liability or only several liability under the construction contract. This may be dictated by the legal
structure of the joint venture itself. Lenders, for obvious reasons, will usually prefer joint and several
liability. Although most projects are structured on the basis that there will be one turnkey contractor,
some projects are structured on the basis that a number of companies are employed by the project
company to carry out various aspects of the design, construction and procurement process which are
carried out under the overall project management of either the project company or a project manager.
This is not a structure favored by lenders as it can lead to gaps in responsibilities for design and
construction. Lenders will also usually prefer that the project company divests itself of responsibility
for project management and that this is assumed by a creditworthy entity against whom recourse may
be had if necessary (Ragazzi, 2005).
Experts: These are the expert consultancies and professional firms appointed by the lenders to advise
them on certain technical aspects of the project. The sponsors will frequently also have their own
consultants to advise them. The areas where lenders typically seek external specialist advice are on the
engineering aspects of projects as well as insurances and environmental matters. Lenders will also
frequently turn to advisers to assist them in assessing risk in connection with the project. Each of these
consultancies' firms will be chosen for its expertise in the particular area and will be retained to
provide an initial assessment prior to financial close and, thereafter, on a periodic basis. An important
point to note is that these consultancies firms are appointed by and therefore answerable to the lenders
and not the borrower or the sponsors. However, the cost of these consultants' firms will be a cost for
the project company to assume and this can be a cause of friction. It is usual, therefore, for a fairly
detailed work scope to be agreed in advance between the lenders, the expert and the sponsors.
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Suppliers: These are the companies that are supplying essential goods or services in connection with a
particular project. In a power project, for example, the fuel supplier for the project will be one of the
key parties. In other projects, a particular supplier may be supplying equipment or services required
during either the construction or the operating phase of the project. Both the contractor and the
operator would also fall under this category. Many of the comments made with respect to the
contractor and the operator will also apply to the suppliers. However, it is not always the case that the
suppliers and for that matter the purchasers are as closely tied into a project structure as, say, the
contractor and operator. The lenders may not therefore be in a position to dictate security terms to
them to the same extent. Where there is no long-term supplier of essential goods or services to a
project, both the lenders and the project company are necessarily taking the risk that those supplies
will be available to the project in sufficient amounts and quality, and at reasonable prices.
Purchasers: In many projects where the project’s output is not being sold to the general public, the
project company will contract in advance with an identified purchaser to purchase the project’s output
on a long-term basis. For example, in a gas project there may be a long-term gas offtake contract with
a gas purchaser. Likewise in a power project the purchaser may be the national energy authority that
has agreed to purchase the power from the plant. However, it is not always the case that there is an
agreed off taker. In some projects such as oil projects there will be no pre-agreed long-term offtake
contract; rather the products will be sold on the open market and to this extent the banks will take the
market risk. In some projects essential supplies to the project such as fuel and the project’s output are
purchased by the project company or, as the case may be, sold on “take-or-pay” terms. In other words,
the purchaser is required to pay for what it has agreed to purchase whether or not it actually takes
delivery.
Insurers: Insurers play a crucial role in most projects. If there is a major catastrophe or casualty
affecting the project then both the sponsors and the lenders will be looking to the insurers to cover
them against loss. In a great many cases, if there was no insurance cover on a total loss of a facility
then the sponsors and lenders would lose everything. Lenders in particular, therefore, pay close
attention not only to the cover provided but also to who is providing that cover. Most lenders will want
to see cover provided by large international insurance companies and will be reluctant to accept local
insurance companies from emerging market countries. In some industries some of the very large
companies have set up their own offshore captive insurance companies, either for their own account or
on a syndicate basis with other large companies. This is, in effect, a form of self-insurance and lenders
will want to scrutinize such arrangements carefully to ensure that they are not exposed to any hidden
risks. In other cases, insurance cover for particular risks either may not be available or may be
available only at prohibitive premiums or from insurers of insufficient substance or repute. In such
cases the lenders will want to see that alternative arrangements are made to protect their interests in
the event of a major catastrophe or casualty.
PROJECT FINANCING DOCUMENTATION
The essence of project financing is the apportionment of project and other risks amongst the various
parties having an interest in that project. The way in which this risk allocation is implemented is,
essentially, through the complex matrix of contractual relations between the various project parties as
enshrined in the documentation entered into between them. There is no general body of law that
dictates how projects must be structured or how the risks should be shared amongst the project parties.
Rather, each project must fit within the legal and regulatory framework in the various jurisdictions in
which it is being undertaken or implemented. Accordingly, the contracts between the various project
parties assume a huge significance and it is these documents that are the instruments by which many
of the project risks are shared amongst the project parties. As will be apparent, there is no such thing
as a standard set of project documents. Each project will have its own set of documents specially
crafted for that particular project. Set out below is a brief description of some of the key documents
found in many projects financing structures (Morea & Gebennini, 2021).
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Pre-Development Agreements: These are agreements entered into by two or more companies that
have agreed to undertake a feasibility study in relation to a proposed project. As the arrangements
between the parties will not usually be sufficiently well developed to warrant a formal shareholders’
agreement, this document can conveniently deal with such matters as initial decision-making and
allocation of tasks in relation to investigating a particular project or proposal. Typically, the agreement
would be for a limited duration and would be quite specific about the scope of the proposed
arrangements and the terms upon which a party could withdraw from the arrangements. It would also
deal with appointment of advisers and general cost sharing. One might also expect to see provisions
relating to confidentiality and restrictions on competing. Similar agreements may also be entered into
where parties join together to bid for a particular contract or concession and do not want to incur the
cost or expense of a formal joint venture agreement or shareholders’ agreement unless they are
successful in their bid.
Joint Venture Agreement: In those projects where the project is being undertaken using a special
purpose vehicle owned by two or more shareholders, those shareholders will usually regulate the
relationship between them by entering into a shareholders’ agreement. On the other hand, where a
joint venture structure is used, a joint venture agreement will usually be entered into. A shareholders’
agreement in relation to a project will not differ greatly from a shareholders’ agreement relating to the
ownership of any other company. A joint venture agreement will contain many of the same provisions
although will not need to deal with those matters concerning the setting up and management of a
special purpose vehicle. It will, however, have to deal with management of the project and voting in
connection with the project generally (Dewar, 2011).
Project Loan Agreement: In most projects this will be a syndicated loan agreement entered into
between the borrower, the project lenders and the facility agent. It will regulate the terms and
conditions upon which the project loans may be drawn down and what items of project expenditure the
loans may be used for. The agreement will contain the usual provisions relating to representations,
covenants and events of default found in other syndicated loan agreements but expanded to cover the
project, project documents and related matters. The provisions relating to the calculation and payment
of interest will be similar for standard Euro-currency, loans except that in most projects interest will be
capitalized during the construction period or until project revenues come on stream. Repayment terms
will vary from project to project and will often be tied to the receipt of project cash flows and/or the
dedication of a minimum percentage of the project’s cash flow towards debt service. The agreement
will normally provide for all project cash flows to flow through one of a number of project accounts
maintained by the agent, or a security trustee or account bank, and charged to the project lenders.
There will be detailed mechanics relating to the calculation of project cover ratios and the preparation
of banking cases and forecasting information with respect to the project. There will also be provision
for the appointment of consultants, advisers and technical experts by the project lenders.
Security Documents: The form of these will vary from jurisdiction to jurisdiction and will depend on
the nature and type of assets that are the subject of the security. In common, law-based jurisdictions
the taking of security in relation to project financing is usually through a fixed and floating charge
covering all of the property and assets of the project company. In civil law based and other legal
systems, however, the position is usually more complex, with different documents being required for
different categories of assets. In those jurisdictions that recognize trusts, it is usually convenient to
appoint a trustee, often one of the banks, to hold the security on trust for the lenders as this not only
insulates the security from the insolvency of the institution holding the security but also facilitates the
trading of rights and obligations by the banks without the risk of disturbing the security. Where a
security trustee is appointed by the project lenders, this is usually under a separate security trust deed
which sets out the terms of appointment, rights, duties and obligations of the security trustee, as well
as provides for the usual indemnity and exculpatory provisions for the benefit of the trustee. Also, the
security trust deed may deal with the order of application of payments amongst the various groups of
lenders, although this is frequently dealt with in a separate intercreditor agreement. The applicable
governing law for a security document will depend to a great extent on the location of the asset over
which security is being taken (Dewar, 2011).
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CONSTRUCTION PROJECT DOCUMENTS
In many projects, particularly Build-Operate-Transfer (BOT) projects, the concession agreement will
be the key project document as it is the document that will vest in the project company the right to
explore, exploit, develop or operate, as appropriate, the concession or other relevant rights to the
project. At the other end of the spectrum, all that may be needed for a project company to be vested
with the necessary legal rights to exploit is a license. On the other hand, in a BOT project, it will
invariably be the case that the project vehicle or its sponsors will be granted a concession by the host
government or one of its agencies with respect to the project. The concession agreement, often
comprising a BOT obligation, but sometimes a build-own-operate obligation, is popular particularly in
countries where political or budgetary constraints prevent governments from developing essential and
increasingly expensive infrastructure in the public sector (Gorshkov & Epifanov, 2016).
Construction Contracts: In an construction project where the project lenders are taking all or any
part of the construction risk, the construction contract will be one of the key project documents. There
are a number of standard form construction contracts in use but it is unlikely any of them will be
suitable for a project-financed contract without significant amendment. The closest to a suitable
international standard contract is probably the “Orange Book” published by FIDIC. The most common
arrangement is a turnkey contract, in which a single “general” contractor assumes all risk of on-time
completion of a project which meets guaranteed performance standards. In a turnkey contract, the
owner specifies overall performance and reliability standards for the plant, and the turnkey contractor
assumes full responsibility for design, construction, supply, installation, testing and commissioning of
the plant so as to enable it to meet those specified requirements. Subject to important limitations which
the contract will contain, the turnkey contractor essentially provides an overall guarantee of the
performance of all components and sub-contractors.
As an alternative arrangement to a turnkey contract, sponsors may consider that they have the
necessary experience to manage the design and construction of the project facility and may wish to
undertake this themselves, or to leave certain responsibilities for it with the project company. Sponsors
may perceive that they will be able to achieve an overall cost or time saving if they perform a role in
relation to some or all of the design or construction of the facility. If construction management
responsibilities are undertaken by the project company or sponsors, lenders will need to be satisfied
with their technical capacity and resources. They may wish to have additional sponsor support to
ensure adequate cover against the absence of a single contractor that has overall responsibility and the
likely consequences of mismanagement during design and construction. Even less popular with
lenders is a project management structure whereby a project management agreement is entered into
with one project managing company which will then arrange for individual contractors to enter into
contracts with the project company. In this case each of these individual contractors would carry out
different parts of the project. One of the reasons lenders have a very strong preference for turnkey
contracts is that they reduce the risk of claims arising between the different contractors and of
unallocated responsibilities relating to the project. If a turnkey contract is not utilized, then the project
lenders will need to spend considerably more time analyzing the construction contracts and the risks
arising from the construction arrangements.
Operating and Maintenance Agreements: Once the project is completed and commissioned it will
then move into the operation stage. The operation of most projects will require an experienced and
skillful operator and the performance of the operator in the performance of its tasks will be crucial to
the overall success of the project. Both the project company and the lenders will be keen to ensure that
the chosen operator is a company that has a proven track record of operating similar projects.
Sometimes it is the case that the project company itself will operate the project although the lenders
will want to be satisfied that it has both the experience and the necessary staffing, in place to
undertake this role. More often, the operator is a third party that specializes in project and facilities
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operation and management and who will enter into an operating and maintenance agreement on arm’s-
length terms with the project company.
CONCLUSION
This paper has provided a guideline to project financing by outlining key features of various
documents that are often found in successful projects. Project financing is an area which requires some
degree of experience. Professional accountants, lawyers, and bankers may provide useful assistance to
a client or customers contemplating a project financing either as a developer or as a lender or investor
in a project. For example, the professional can assist a client or customer in developing the forecasted
statement of operating revenues and expenses which is required by lenders and investors as part of the
evaluation package for a project finance loan or equity investment. In addition, the professional can
assist a client or customer in selecting the business form in which the project will operate. Careful
structuring is necessary in order to achieve the most efficient use of tax benefits which are often of
major concern to the equity investor in the project. It is important to remember that a successful
project financing is executed as a team effort involving a developer, one or more lenders, equity
investors, and a variety of advisors ranging from investment bankers to attorneys, engineers, and
accountants.
REFERENCES
Bueno, J. C. (2010). Project Finance: Challenges and Trends. In 10ª Conferência Internacional da LARES.
LARES. São Paulo.
Danielis, R., & Rotaris, L. (2021). Transport Project Financing.
Delmon, J. (2017). Public-private partnership projects in infrastructure: an essential guide for policy makers.
Cambridge university press.
Dewar, J. (Ed.). (2011). International project finance: law and practice. Oxford University Press
Finnerty, J. D. (2007). Project financing: asset-based financial engineering (Vol. 386). John Wiley & Sons.
Gorshkov, R., & Epifanov, V. (2016). The mechanism of the project financing in the construction of
underground structures. Procedia Engineering, 165, 1211-1215.
Morea, D., & Gebennini, E. (2021). New Project Financing and Eco-Efficiency Models for Investment
Sustainability. Sustainability, 13(2), 786
Ragazzi, G. (2005). Tolls and project financing: a critical view. Research in Transportation Economics, 15, 41-
53.
Steffen, B. (2018). The importance of project finance for renewable energy projects. Energy Economics, 69, 280-
294.
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